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3 Revision – Elasticity of demand

and supply
Elasticity: A measure of the responsiveness of how much
something changes when there is a change in one of the
factors that determines it.
Elasticity of demand: A measure of how much the
demand for a product changes when there is a change in
one of the determinants of demand.
Price elasticity of demand: A measure of how much the
quantity demanded of a product changes when there is a
change in its price.
Cross elasticity of demand: A measure of how much the
demand for a product changes when there is a change in
the price of another product.
Income elasticity of demand: A measure of how much
the demand for a product changes when there is a change
in the consumer’s income.
Price elasticity of supply: A measure of how much the
quantity supplied of a product changes when there is a
change in its price.

Price elasticity of demand (PED)

Percentage change in quantity demanded of the product

Formula: PED 5 ​ ___________________________________________________
            ​
Percentage change in price of the product

The range of values is from zero to infinity. PED is perfectly

inelastic when the value is zero. PED is inelastic when the value is
between zero and 1. PED is unitary when the value is 1. PED is
elastic when the value is between 1 and infinity. PED is perfectly
elastic when the value is infinity. TR = Maximum
Price/TR ($)

Perfectly inelastic Perfectly elastic

PED is
greater
Price ($)

Price ($)

D1
than 1

P2 PED = 1 TR
P1 PED is
D1 = AR = MR lower
P1 than 1

0 Q1 0 D = AR
Quantity Quantity 0
MR Quantity
Values of PED for a normal demand curve will fall as the MR = 0
price falls, i.e. as we go down the demand curve.
Revenue boxes may be used to
l If PED is elastic, then total revenue can be increased by show the same relationships, e.g.
lowering the price of the product. when demand is relatively elastic, a
l If PED is inelastic, then total revenue can be raised by fall in price from P1 to P2 leads to
increasing the price of the product. an increase in revenue of (b – a).
l If PED is equal to 1, then total revenue is being maximized.
Price ($)

The determinants of PED are:

l the number and closeness of substitutes – the more substitutes it
P1
has, the more elastic will be the demand for a product a
P2
l the necessity of the product and how widely it is defined – the less
b D1
necessary it is, the more elastic will be the demand for a product
l the time period being considered – the longer the time period 0 Q1 Q2
being considered, the more elastic will be the demand for Quantity
a product.

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 Revision ● Elasticity of demand and supply

Cross elasticity of demand (XED)

Percentage change in quantity demanded of product X

Formula: XED 5 ​ _________________________________________________
            ​
Percentage change in price of product Y

The range of values is important. The sign tells us the

relationship between the goods.
l If the value of XED is positive, then goods are substitutes for
each other, e.g. Coke and Pepsi. The larger the value, the closer
the relationship.
l If the value of XED is negative, then goods are complements for
each other, e.g. DVD players and DVDs. The larger the value,
the closer the relationship.
l If the value of XED is zero, then the goods are unrelated, e.g.
strawberries and mobile phones.

The determinants of XED are the relationships between the

goods in question, as shown above.

Income elasticity of demand (YED)

Percentage change in quantity demanded of the product

Formula: YED = ___________________________________________________
​       
       ​
Percentage change in income of the consumer

The range of values is important. For normal goods, the value of

YED is positive, i.e. as income increases the demand for the good
increases. If the value is between zero and 1, then the YED is said
to be income inelastic. If the value is greater than 1, then the YED
is said to be income elastic.
The sign tells us the type of good that is being considered.
l Necessity goods are products that have low-income elasticity,
essential products, e.g. bread.
l Superior goods are products that have high-income elasticity,
non-essential products, e.g. foreign holidays.
l Inferior goods are products that have negative income elasticity,
because the demand decreases as income increases, e.g. cheap
wine or non-brand name jeans.

The determinants of YED are the types of goods in question, as

shown above.

Price elasticity of supply (PES)

Percentage change in quantity supplied of the product

Formula: PES 5 ​ _________________________________________________
            ​
Percentage change in price of the product

The range of values is from zero to infinity. PES is perfectly

inelastic when the value is zero. PES is inelastic when the value is
between zero and 1. PES is unitary when the value is 1. PES is

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 Revision ● Elasticity of demand and supply

elastic when the value is between 1 and infinity. PES is perfectly

elastic when the value is infinity.
Perfectly inelastic Perfectly elastic Unitary elastic
Price ($)

Price ($)

Price ($)

Price ($)
PES is S1
S1 S1
elastic S2
S2
P2
P1 S1
P1 S3
PES is
inelastic
0 0 Q1 0 0
Quantity Quantity Quantity Quantity

In international trade, it is assumed that the supply of

commodities, such as wheat, available to a country for import is
perfectly elastic, because consumers can import all that they want
as long as they are prepared to pay the ‘world price’.

The determinants of PES are:

l how much costs rise as output increases – if total costs rise
significantly as a producer attempts to increase supply, then
supply will not be raised and so supply will be relatively inelastic
l the time period being considered – the longer the time period
being considered, the more elastic will be the supply of a product.
In the immediate time period, PES will be perfectly inelastic. In
the short run, as firms can change variable factors, PES will
become more elastic. In the long run, when firms can change all
factors, PES will be even more elastic.

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